Factoring and Forfaiting

Shyam Prakash U
us.prakash@gmail.com
Intro
• Firms can benefit by selling their accounts
receivables for cash.
• To increase their cash flows and reduce their
outstanding recievables.
• Factoring and Forfaiting are services that cater
to these requirements of firms and assist in
domestic and international trade.
Factoring
In factoring , factor ( a bank or a FI ) takes the
responsibility of collecting the accounts
receivables for a client ( firm ). According to
the arrangement, the client sells invoiced
receivables at a discount to the factor. This
helps the firm to immediately raise finance for
any working capital requirement.
Factoring
The factor provides services such as financing,
collections, and sales ledger administration. It
is up to the factor to accept the credit risk
involved in the transaction.
Factoring is an ongoing arrangement and not a
one time transaction.
Advantages of Factoring
• Replaces high cost credit – Enables purchases on
cash basis for availing cash discounts.
• Instant finance – against the invoice.
• Improves cash flow – factoring requires a very
low margin ( upto 20% ) thereby improving cash
flow.
• Large credit / grace period – Enables customer.

• Invoice follow up – the factor follows up for each

invoice for payment after the due date and there
after.
Advantages of Factoring
• MIS reports - the factor takes care of the MIS
reports and the sales ledger administration.
• Increased ROI – accelerates the receivables
turnover and improves operating cycle,
resulting in production, larger sales, higher
profits and increased ROI.
Types of Factoring
• Recourse Factoring – the client has to bear the
risk of bad debts or non payment of invoice.
• Non recourse factoring – the factor has to
bear the risk of bad debts. The factor provides
both finance and credit protection.
Domestic Factoring
• Receivables arising out of domestic trade
• The supplier or borrower draws bills of exchange for goods supplied
and the purchaser accepts it.
• Post acceptance the factor makes a prepayment of 80% of the
invoice (-) the discount charges at normal interest rates.
• The payment is for the period of bill of exchange to the supplier.
• The balance payment is made after the collections.
• If the purchaser fails the supplier makes good the payment
• The maximum permissible debt period for factoring is 150 days
inclusive of 60 days of grace.
• Various MIS reports like Debtor ageing analysis, Weekly Statement
of accounts, Sales analysis and Statement of outstanding invoices
and given to the seller by the factor.
International Factoring
• Two factors are prevalent: Import factor and
export factor.
– Export factor looks at exporter financing and sales
administration
– Import factor is interested in evaluating the buyer,
collecting money on time and at the same time
ensuring that he is protected against default.
International Factoring
• The importer places an order with the exporter.
• The exporter requests the export factor for limit
approval on the importer.
• The export factor, in turn forwards this request
to the import factor in the importer’s country.
• The import factor evaluates the importer and
conveys its approval to the export factor, who in
turns conveys the commencement of the
arrangement.
International Factoring
• The exporter delivers the goods to the importer.
• The exporter produces the documents to the export
factor.
• The export factor disburses the funds to the exporter
upto the prepayment amount decided and at the same
time forwards the documents to the import factor.
• The importer on the due date of the invoice pays the
import factor who in turn remits the payment to the
export factor.
• The export factor applies the received funds to the
outstanding amount of the advance.
• The exporter receives the balance payment.
Forfaiting
• The word is derived from the French word “ a
forfait “ which mean to surrender or
relinquish a right to someone.
• The exporter gives up his right to future
export receivables in return for cash from an
intermediary called a forfaiter.
Forfaiting
• It involves discounting of trade receivables such as
drafts drawn under LCs, Bills of exchange, promissory
notes, or other freely negotiable instruments.
• The discounting is done on “no recourse “ basis to the
exporter, in case fails to pay on the due date.
• Its generally used for medium and long term
receivables.
• Its usually extended for capital goods and large
projects and is carried out on single transaction basis.
Mechanism of Forfaiting
• The exporter signs a contract with the importer
for sales of goods at a negotiated price and credit
period. The exporter informs the importer that
he would discount the sales receivables with a
forfaiter and assign the receivables to the
forfaiter.
• The importer’s bank issues a LC in favor of the
exporter.
• The exporter enters into a forfaiting contract. The
exporter draws debt instrument accepted by the
importer.
Mechanism of Forfaiting
• The unconditional stand by LC of the importer’s
bank back the debt instuments.
• The forfaiter sends these documents to the
importer’s bank, who inturn notifies reciept.
• The forfaiter pays 100% to the exporter after
discount and other incidental charges as per the
contract.
• The forfaiter then takes over the responsibility
for claiming the debt from the importer and
holds the notes till full maturity.
Docs required by the forfaiter from
the Exporter
• Under the forfaiting agreement, a promissory
note, bill of exchange is issued for each
installment of the suppliers credit,
documenting the existence of the exporter’s
claim on the importer, if it is an unconditional,
irrevocable, and divorced from the underlying
trade transaction.
Docs required by the forfaiter from
the Exporter
• Copy of the supply contract
• LC confirming to the UCPDC
• Copy of the signed commercial invoice
• Copy of the shipping documents like bill of
lading , airway bill etc.
• Letter of assignment and notification to the
guarantor.
Advantages of Forfaiting
Exporters can gain a lot by using forfating as a financing method
• Full financing; provides 100% financing without recourse and not
occupying the exporter’s line of credit.
• Cash flow improvement; improves cash flow by converting
receivables into cash inflows.
• Cost saving; savings on administrative costs.
• Trade Opportunity; increases the trade opportunity as the exporter
is able to grant credit and become more competitive.
• Realisation of Price transfer; helps to realise price transfer as the
exporter can also transfer the corresponding finance cost into the
sale price.
• Risk avoidance; avoids various risk arising from deferred payments